In a recent
cartoon a man opens a letter and says to his wife, “It’s a tax refund.There’s a note attached asking us not to cash it until next week.”

But enough of
levity:The Fed has hinted that
they might allow interest rates to rise and stock and bond markets have
panicked.While higher interest
rates will certainly have implications for stocks, bonds, and the general
economy, we all knew that a rise was an inevitability.I would point out that the rationale for higher rates is a positive one:an economic recovery; and I, for one, am fairly confident
that the Fed will not damage that recovery.

The first five
months of the year were marvelous for stocks, while the bond market basically
flatlined over that period.(What
could one expect, what with rates that have hovered near zero for the last
couple of years?)But then came that hint from the Fed and the reverie was
shattered.Both stocks and bonds
tumbled.By the time we hit bottom
near the end of the quarter, over six percentage points had been shaved off the
Dow Industrials. The major bond
indices lost
“only” around 3.5% in those last few weeks, though long-dated paper fell more than 10%.

Before that, bonds
had trended slightly lower for the first two quarters.Stocks were able to end the quarter in plus territory, notwithstanding
the messy ending of the period, and the major stock indices remain double-digit
positive for the year-to-date.

I have been
purposely allowing cash to build up in both my stock and bond accounts as the
market has risen.Some people get itchy when cash builds in their investment
accounts, but that itch miraculously disappears when the market tumbles.When, over just a couple of weeks, you see a thousand points lopped off the
recent all-time highs, it becomes clear that cash is a legitimate investment
option.While stocks mounted a
quick recovery, regaining 500 Dow points in just a handful of days, doubt has
certainly crept into the market and remains there.I confess that I like to buy on sale, and after that thousand point drop
I did find a few stocks to nibble on.

In bonds, however,
there is very little doubt:it
seems to be consensus that the carnage is not over just yet.I continue to defer new bond purchases.

In a physics class
the professor asks “Which falls faster, a pound of bricks or a pound of
paper?”An economics student in
the class asks, “Is it 30-year paper?”

Long-dated bonds
(the previously mentioned 30-year paper) have fallen faster and farther than
shorter paper, as would be expected.That is why I have emphasized shorter maturities for the last
several years.Still, we get hurt
when rates rise.In times like
these, bondholders must remember to focus on the income and not the market
value.To paraphrase John Bogle, it
doesn’t matter what happens to the market value of your securities as long as
the income (dividends and interest) keeps coming in.It is, however, a very rare investor indeed who is capable of ignoring
sharp declines in his account value.

In our bond
allocations we are as well prepared to weather the potential upheaval as is
possible. This is a long-term game, in which
you must correctly allocate your funds while suffering through the inevitable
periods of pain.Patience and logic
will produce a winning result over time.Remember
that rising markets are the norm over the long term, and that declining markets
may be swift, sharp, and painful, but they tend to be of much shorter duration.Such markets also often present us with opportunity.